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Regulated milk price and quantity

Hon Jim Anderton

Minister of Agriculture, Minister for Biosecurity Minister of Fisheries, Minister of Forestry Associate Minister of Health Associate Minister for Tertiary Education

22 August 2008 Media Statement

Regulated milk price and quantity the same next year.

The time is not right for increases in the price of milk and dairy products for domestic consumers, Agriculture Minister Jim Anderton said today.

He announced the existing formula that determines the price of regulated milk will be retained for next year. Regulations will also be introduced to keep the quantity of regulated raw milk at 600 million litres for next season and beyond.

Legislation will be drafted to introduce an auction for raw milk for the following year, the 2010/11 dairy season.

The majority of milk and dairy products sold in New Zealand are supplied under regulation. The regulations currently set a default price at which Fonterra has to supply raw milk to other processors.

The decisions follow a review ordered by the Government last year into raw milk regulations.

The review found that the formula for setting the default price results in independent processors accessing Fonterra milk under the regulations at a lower price than Fonterra pays its own suppliers. It also found there is no mechanism in the regulations to manage excess demand for regulated milk by independent processors.

“If the default pricing formula was kept beyond next season it would create a real risk of processors making investment decisions that are economically unsustainable and could lead to over-capacity in the industry. An auction is a fair way of setting prices,” Jim Anderton said.

The government consulted widely on the review.

The Commerce Commission recommended that the quantity of regulated milk should be increased to five percent of Fonterra’s supply. The Commission also recommended a review of sunset clauses in the Dairy Industry Restructuring Act. These clauses require Fonterra to supply regulated milk until a level of competitive supply is available. When the sunset ‘triggers’ are met, the obligation to provide regulated milk will abruptly end. The government believes those levels are likely to be met as early as 2013 or even earlier.

The effect of the Commerce Commission’s regulations would be to compel Fonterra to provide significantly greater quantities of regulated milk indefinitely.

Jim Anderton says the government shares the Commission’s concerns about an abrupt end to the obligation to supply regulated milk. It believes an auction is the best way to manage the transition risks identified by the Commission.

“The introduction of an auction from the 2010/11 season will remove uncertainty for Fonterra, independent producers and for farmers. It will allow a price to be found that matches demand and supply. MAF forecasts indicate that by 2010/11 the domestic wholesale price of milk will fall relative to this year’s price.

“There have been considerable concerns expressed by some players about how an auction would operate. Small scale and niche processors have been particularly concerned about security of supply, scheduling rules and auction lot sizes.

“The government will ensure small independent processors will be guaranteed supply at no more than the average auction price.”

The full design details of the auction are yet to be finalised but considerable effort has gone into resolving these concerns.”

In deciding to introduce an auction, the government considered a range of alternatives.

“We could have set a price only for next season, but that would be irresponsible because it would effectively mean that all the same issues would have to be worked through again next year,” Jim Anderton said.

Another option would have moved to the higher ‘farm gate’ milk price next year before moving to an auction. (The farm gate price is the milk component of the Fonterra payout.) The government decided that the potential for lags in domestic prices and uncertainty over international dairy prices meant the time was not right for any even potential increase in domestic dairy prices.

The government also looked at legislating to create a two-tier pricing system that would mean independent processors with their own milk supply would pay a higher ‘exporter’ price, while small-scale processors and those without their own supply, including competitors to Fonterra’s brands, would continue to pay the default price.

A further option would have managed excess demand by imposing time limits on big processors with their own supply.

“These options did not adequately address the transition to new arrangements when Fonterra no longer has an obligation to supply regulated milk and were not likely to be seen as fair by Fonterra’s competitors.

“In the current economic environment, it is not responsible to take decisions that could increase the price of milk for domestic consumers next year. We also need to prepare for the competitive issues that come up as the volume of milk produced reaches levels specified in the Dairy Industry Restructuring Act. The decisions announced today accomplish all of those goals.”

www.beehive.govt.nz/anderton or www.progressiveparty.org.nz

This statement is issued by Jim Anderton. MPs' press releases and speeches are part of the normal course of business of elected representatives. We do not believe they are election advertisements within the Electoral Finance Act, and nor was the Act intended to apply to them. However, because some people are confused about the Act, and because the Progressive Party is proud to confirm our responsibility for what we say, this statement is authorised by Phil Clearwater, 5 Sherwood Lane, Christchurch.

Background

The Dairy Industry Restructuring Act (2001) (the DIRA) and Dairy Industry Restructuring (Raw Milk) Regulations 2001 (the Regulations) were part of a suite of pro-competitive measures agreed at the time of the 2001 industry restructuring, aimed at mitigating the effects of creating a single firm with around 95% of New Zealandâ's milk production.

The DIRA gives the Government the ability to regulate up to 5% of Fonterra's milk supply. Based on the 2006/07 season, this equates to approximately 750M litres.

The intentions behind the Raw Milk Regulations were: to protect the position of firms that previously purchased milk from either of Fonterra's predecessor cooperatives

to protect NZ consumers from anti-competitive behaviour from Fonterra

to provide an entrance pathway for new processors

The obligation on Fonterra to supply regulated milk was set at 400M litres a year between 2002/03 and 2006/07.

The 400M litre block of regulated milk was never intended as 'cheap milk' or to attract entry into the industry on the basis of 'cheap milk'. The intention was always that the milk would be fairly and efficiently priced.

Regulated milk is priced via the default pricing formula, which is contained in the Regulations. This is referred to as 'the default price'.

Why was there the need for a Review? The Government announced a Review after the Regulations came under pressure in June 2007, as Fonterra did not adequately manage the transition to an excess demand for regulated milk by independent processors. The uncertainty that resulted had the potential to cause significant industry disruption including company failures.

To avoid the prospect of significant disruption the Government increased the quantity of regulated milk to: 500M litres for the 2007/08 season; 600M litres in the 2008/09 season ; and Reverting back to 400M litres in the 2009/10 season pending the outcome of the Raw Milk Review.

A key element of the review was how milk is priced under the Regulations.

The Government also announced that the review was to be completed in sufficient time to allow time for any changes to the Regulations to be made by the end of 2008 in preparation for the 2009/10 season.

What did the Review find? The review identified three issues: The current default pricing formula is pricing regulated milk lower than Fonterra pays its own suppliers; The Regulations do not manage situations of excess demand for regulated milk by independent processors; and There is an unmanaged transition risk associated with the prospective ending of the statutory obligation on Fonterra to provide regulated milk due to the sunset clauses (or triggers) contained in the Dairy Industry Restructuring Act.

How will excess demand be managed? The Regulations will be amended to allow the pro-rata (or equal proportion) rationing of all processor if excess demand occurs prior to the auction being introduced.

Following the introduction of the auction excess demand will be managed by adjusting price to match supply and demand.

How will the auction work? While the fine details of the auction design will be finalised at the time an amendment Bill is introduced, the auction is likely to be run annually, employ an online platform, and be a simple ascending auction. It will also be a closed auction where only registered independent processors can participate.

The auction will allow independent processors to bid for the right – and potentially the obligation – to purchase raw milk at the Fonterra farm gate price.

The auction will allow independent processors to build a ‘milk portfolio’ subject to the existing processor limits. Once independent processors have their profile, they then schedule this in accordance to the current rules (e.g. the October rule and notice periods).

How will the auction address independent processor concerns such as contractual terms, ability to secure milk, and lot size? While the fine details of the auction design will be finalised at the time an amendment Bill is introduced, the following features are likely to incorporated:

A definition of ‘small processors’ that is significantly larger than that outlined by the Raw Milk Review Consultation document (e.g. 12M litres per annum); and A dedicated ‘pool’ of 40M litres that provides small processors with a minimum grand parented allocation (up to 4M litres) and the ability to ‘top up’ this amount through the auction process up to 12M litres

It is intended that any small processor who requires less than 4M litres will be able to access up to that amount directly from the dedicated pool, at the average auction price, without having to bid for milk at the auction (implying that for affected processors the system would be virtually identical to the status quo).

These initiatives should also go a long way towards addressing processor concerns about minimum lot sizes.

It is also intended that for the first year there is likely to be some level of excess supply, which will ensure a smooth transition to the auction. The Government therefore reserves the right to set a fair and reasonable reserve price.

What are the DIRA triggers? Once a level of competition has been established, the statutory obligation on Fonterra to provide regulated milk ceases. The triggers are contained in sections 147 and 148 of the DIRA. There are North and South Island components: The South Island trigger is based on 65M kgMS (approx 780M litres) being collected by independent processors in total; of which 25M kgMS (approximately 300M litres) is collected by a single processor outside of the boundaries of the Westland Regional Council. The North Island trigger is based on Fonterra’s share of total milk falling to 87.5%.

MAF forecasts that the triggers could be met as early as 2013 (and potentially sooner).

ENDS

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